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South Africa's budget: first steps towards a recovery, but at what cost?

The 2018 Budget, presented by Finance Minister Malusi Gigaba in Parliament, lays out the painful consequences of the country’s public finances for South Africans.

The National Treasury’s proposal of an increase in Value Added Tax (VAT) – a tax applied to most items consumers buy – from 14% to 15% is the most dramatic of these consequences. Because it’s a tax paid by all citizens, putting it up by 1 percentage point raises concerns about the negative effects on the poorest households.

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The Budget also proposes that tax brackets for the highest-earning 1 million taxpayers will not be adjusted for inflation, which effectively increases income taxes for these taxpayers.

Another sign of the distress the country’s finances are in came in the form of proposed cuts to government infrastructure spending, especially at local and provincial government level. The need for expenditure cuts is exacerbated by the fact that the budget supports former president Jacob Zuma’s commitment to provide free higher education for a greater number of students. The minister said that the policy would be phased-in, with the Budget indicating that the cost rises from R12-billion to R24-billion over the next three years. But there are reasons to believe the cost could be higher.

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Whether measures announced by Gigaba will stave off a downgrade of South Africa’s local currency debt by the one remaining rating agency remains to be seen. While the ascension of Cyril Ramaphosa to the presidency has provided hope that pressure on public finances will be reduced by the state being better managed, it will take years to significantly improve the current situation.

A substantial shift

In October last year Gigaba painted a grim picture of South Africa’s public finances in the 2017 Medium Term Budget Policy Statement. With an expected R50-billion shortfall in tax revenue he indicated that national debt would increase rapidly – contrary to repeated earlier promises to “stabilise” debt levels.

The 2018 Budget reflects a substantial shift from this position. The new plan is to return to a strategy of “debt consolidation”: reducing the speed at which national debt increases relative to the size of the economy, so that within a few years it begins to decline.

Debt will still increase to levels higher than promised in numerous previous budgets, but significantly slower than suggested in October. Reducing the rate at which the government borrows requires raising more money from taxes and decreasing planned government expenditure. But this is even more difficult to do because of Zuma’s announcement of “free higher education” – which happened after the medium term budget statement.

Essentially, expanded free higher education means a combination of more taxes, more spending and more borrowing.

1. The impact of VAT increase: Of all the major taxes available, VAT is the least “progressive”. It is paid to a much greater extent by the poor and vulnerable than personal income tax or corporate tax. It is arguably for this reason, in the context of South Africa’s high rates of income and wealth inequality, that VAT has not been increased since 1994.

The increase has been defended on the grounds that other options (personal and corporate income tax) are increasingly strained and VAT is the least harmful to economic growth. The claim about economic growth is debatable: it depends on assumptions about how the economy works. And although the budget claims that social grants have been increased to try and offset the negative impact, the overall effect remains unclear. It seems likely that most poor households will experience additional hardship.

2. Free higher education: The budget repeatedly states that the costs of Zuma’s free higher education announcement “remain uncertain”. This is strange and probably reflects the fact that Zuma violated normal budget protocol by almost unilaterally announcing the policy change without adequate consultation or analysis of the likely costs. Nevertheless, it is surprising that the budget does not provide more detail.

The budget indicates additional government expenditure of R12.4-billion in 2018/19, increasing rapidly to R20.3-billion in 2019/20 and R24.3-billion in 2020/21 as the policy is rolled out beyond just first year students. But these numbers look optimistic. Treasury does not explain what it has assumed about the number of students needing support and how much support will be provided.

3. Expenditure cuts: The budget proposes R85-billion in cuts to planned government spending over the next three years. It’s hard to tell what the implications of spending cuts really are just from looking at the numbers and explanation in the budget. Nevertheless, a couple of things are clear.

Firstly the cuts affect infrastructure spending in particular: about R40-billion is cut. In some ways this is understandable. But it’s also dangerous because these decisions seem, for now, less harmful than they really are. That’s because South Africa’s economic and social infrastructure is already a matter of concern and the additional negative consequences of underspending will only be noticed years down the line.

Secondly the cuts are targeted at provincial and local government: R28-billion will be cut in grants given to local and provincial governments for various infrastructure programmes. This is also concerning given the importance of service delivery at these levels.

The gaps

The National Treasury needs to provide more information on why the decision was taken to increase VAT, and what the implications are likely to be. This is important because the move raises concerns about the effects on poorer and more vulnerable South Africans.

A detailed explanation of the likely costs of the proposed policy to expand free higher education also needs to be provided. The absence of this information raises concerns about whether Treasury has allocated enough money for this policy and, if not, whether universities may be left to deal with the consequences of insufficient funding for students who have been promised free higher education.

Finally, the attitude of the National Treasury in recent budgets has been that provinces and municipalities simply need to become more efficient and must fulfil their obligations with fewer resources. But what if that’s not possible? The Treasury can’t wash its hands of the negative consequences of cuts to critical areas of service delivery.

In conclusion, the Budget represents progress since last year when Zuma and his cabinet effectively sat on their hands and refused to take any difficult decisions. At least proposals have now been made to stabilise the national debt. Whether they represent the best solutions to our public finance challenges is a matter for public debate.